England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT (CHANCERY DIVISION)
The Chancellor of the High Court
[2008] EWHC 1839 (Ch)

		Royal Courts of Justice Strand, London, WC2A 2LL
		25 June 2009

Lord Justice Moses :

1. Prior to its repeal by the Finance Act 2002, Chapter II of Part IV of the Finance Act 1994 contained a statutory code for the taxation of currency contracts. In 2002 Prudential entered into two foreign exchange hedging transactions, the first with the Royal Bank of Scotland ("the RBS hedge"), the second with Goldman Sachs International ("the GSI hedge"). Following Ernst and Young LLP's presentation of a tax-efficient method of hedging exchange rate risks, the transactions were structured so that two payments, called "the front end payments", were made at the inception of the two hedging transactions.
2. Prudential claimed that those two front end payments were "qualifying payments" under "qualifying contracts" for the purposes of the statutory code; they were payments made in consideration of RBS and GSI entering into the hedging contracts. If that was correct, those two payments, of £105 million, (amount B, in the algebraic statutory code) exceeded the amount of "qualifying payments" received (amount A) by £105m. Prudential did not receive any qualifying payments. Accordingly, it sought a deduction in its corporation tax return in that amount.
3. The Revenue said that those payments were not qualifying payments. Deductible qualifying payments do not include the principal paid on the acquisition or sale of foreign currency. They were no more than prepayments of part of the final exchange of principal under the hedging agreements. The Special Commissioners agreed with the Revenue that the two front end payments were not qualifying payments and dismissed Prudential's appeal [2008] STC (SCD) 239, BAILII: [2007] UKSPC SPC00636. On Prudential's appeal, the Chancellor agreed [2008] EWHC 1839(Ch) [2008] STC 2820. Prudential advances its arguments for a third time with the permission of a single judge of this court. Unless it succeeds, two further issues, as to the meaning of the allocation provisions under s.155(4) and(5), and as to whether the main purpose was tax avoidance, unallowable by virtue of s.168A, both of which the Special Commissioners decided against Prudential (§§ 59-87), do not arise.
4. Now that four judges have considered Prudential's contention, it is tempting to think that it would be a matter of supererogation to give, for the third time, an account of the relevant facts and a recitation of the relevant statutory provisions. The facts can be found in §§ 9-44 of the decision of the Special commissioners and in §§ 16-23 of the judgment of the Chancellor. The statutory provisions are set out in §§ 45-51 of the Special Commissioners' decision and §§ 8-15 of the judgment of the Chancellor.
5. Both hedges were made for the legitimate commercial purpose of protecting Prudential, in the case of the RBS hedge, against an increase in the value of Euros relative to Sterling and, in the case of the GSI hedge, against diminution in the value of the US Dollar relative to Sterling. The need for the RBS hedge arose out of the issue of €500 million debt, with a maturity date on 19 December 2021 but which could be called in by Prudential on its tenth anniversary. The need for the GSI hedge arose in consequence of a loan by Prudential's, "treasury" subsidiary, PFUK, of $250m.
6. It was agreed that in March 2002 the spot rate for €500m was £309m. But for the presentation by Ernst & Young to Prudential's tax team, Prudential would have paid £309m for €500m. But under the terms of the confirmation of the RBS Hedge, contractually effective pursuant to the standard form ISDA Agreement, Prudential agreed to pay RBS £65m on 12^th March 2002. This was described as an "Additional payment…in consideration of (RBS) entering into this Transaction". Under the terms of confirmation, Prudential agreed to pay £244m in exchange for €500m from RBS on 19 June 2002.
7. It was agreed that, in August 2002, the spot rate for $250m was £163m. Prudential decided to follow the same structure it had adopted, in the earlier hedge, at the suggestion of Ernst & Young. But for that decision, Prudential would have sold $250m to GSI for £163m. On 23^rd August 2002 under the terms of the contractually binding confirmation, Prudential agreed to pay GSI £40m, described as "an Additional payment…in consideration of GSI entering into this Transaction". Under the terms of the confirmation, Prudential agreed to pay GSI $250m and GSI agreed to pay Prudential £203m on 25^th November 2002.
8. To qualify under the statutory scheme, a currency contract must contain a provision under the contract for the exchange of one currency for another, at the same time on maturity of the contract (ss147(1) and 150(1) and (2)). To enter into the calculation of profit or loss, a payment under a currency contract must be a qualifying payment (s.155(2) and (5), and s.153(1)(d)). In the instant appeal the only candidates were the payments of £65m under the RBS hedge and £40m under the GSI hedge. Qualification depended on establishing a:

"….provision under which the qualifying company—

…

(b) becomes subject to a duty to make a payment in consideration of another person's entering into the contract…"(s.151(1)(b)).

9. Whilst s.151(1)(b) envisages that the obligation to make the payment will arise under the very contract which the counter-party entered in consideration of such a payment, s.153(2) includes within the definition of "qualifying payment", a payment :

"… which, if it were a payment under the contract, would be a payment falling within section 151 above".

10. There are two essential features of the qualifying payment identified in s.151(1)(b): firstly, that it should have the function of an inducement to the counter-party to enter into the contract, and secondly, that it is distinct from payments, such as principal payments on maturity, made in fulfilment of the contract itself. These were features recognised by the Special Commissioners and by the Chancellor (§40). I can do no better than to recall the Special Commissioners' affirmation of these important features of the statutory scheme and the reasoning which followed:-

"54. The words of s 151(1)(b) 'a payment in consideration of another person's entering into the contract …' are, as we read them, directed at payments which have the function of securing the making of the contract; they are to be distinguished from payments made in fulfilment of the contract itself. Payments of the kind listed in s 151(2) are within s 151(1); an example might be an inducement payment. Payments of the kind referred to in s 150(2) to (4) are examples of payments relating to the principal amounts covered by the contract which are outside the scope of s 151.

55. The RBS contracts were entered into to cover Prudential's exposure to increases in value of its liability in respect of the €500,000,000 indebtedness. Prudential's liability in respect of the €500,000,000 debt had a sterling value of £309,000,000. £309,000,000 was the amount required by RBS in return for its undertaking to transfer €500,000,000 to Prudential on 19 June 2002. The reason for the £65,000,000 paid on 12 March is found in two features of the evidence. First, the Ernst & Young Opportunity depended for its success on, to use the words of the presentation slide, 'in economic terms the prepayment of part of the principal exchange under [the] swap'. Second, Mr Foley admitted that the quantum of 'the premium' (or front end payment) would determine the quantum of the tax benefit. Mr Foley's evidence simply recited how under the terms of the swap Prudential was required to pay a premium of £65,000,000 as consideration for RBS entering into the swap on the terms agreed; he went on to say that the amount represented the Group's available cash. The description of the front end payment in the RBS short-term swap contract as paid 'in consideration of The Royal Bank of Scotland Plc entering into this Transaction' seems to us to have been chosen to suit the Ernst & Young Opportunity. But as a statement of what really happened it was a misnomer, a deliberate mislabelling. It was part of the consideration under the contract. It cannot have been the intention of Parliament that any consideration under a currency contract was within s 151(1).

56. The £40,000,000 front end payment under the GSI contract was even less consideration 'for entering into the contract'. The idea behind it was to reproduce the tax savings sought from the RBS short-term swap. The up-front payment of the £40,000,000 which was to be returned later makes no sense save in the context of the tax scheme. The amount of the tax benefit was determined by the funds of idle cash at Mr Foley's disposal. There is, as with the RBS short-term swap, no evidence that GSI required a £40,000,000 inducement to enter into the swap which had been structured on arm's length terms and by reference to the prevailing exchange rates.

57. Properly understood both front end payments were, we think, payments on account or part pre-payments made by Prudential relating to its principal liabilities under the two contracts. Despite the wording of the Confirmation documentation, they were not, in the circumstances and on the plain wording of s 151(1)(b), payments 'in consideration of another person's,' i.e. RBS's and GSI's as the case might be, 'entering into the contract'. We do not need examples of other types of payments that may or may not fall within the scope of s 151(1)(b) to assist us in reaching that conclusion."

11. The Revenue has never contended that the contracts were sham, in the sense that the references to additional payments were intended to mislead. Fortified by the Revenue's approach, Mr Peacock QC, on behalf of Prudential, suggested that the court must confine its attention to the terms of the contract, which the parties chose to make.
12. The statutory question is whether the two "front-end" payments were made in consideration of RBS and GSI entering into their respective currency contracts. Mere incantation by the parties of the words of statutory qualification does not produce the desired fiscal effect. A payment does not come within s.151(1)(b) merely because the parties say it does. In a different statutory context, Lord Templeman encouraged calling a fork a fork:

"The manufacture of a five-pronged implement for manual digging results in a fork even, if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade"( Street v.Mountford 1985 AC 809 at 819).

13. The distinction between payments made in fulfilment of the contract and payments which secure the making of the contract depends on "substance and not on the mere name" (Westminster Bank Ltd v. Riches [1947] AC 390). This is not a process of ignoring the legal effect of a transaction because its purpose or main purpose was to obtain a tax advantage, or to avoid tax. That is a different issue (it was the third issue in the Special Commissioners' decision); it arises only if it is necessary to consider the tax avoidance measure in s.168A "Qualifying contracts for unallowable purposes". On the contrary, the task of the Special Commissioners and of the Courts, once the taxpayer attempts to clamber up the appellate ladder, is to apply the language of the section to the facts of the case. Lord Hoffmann shows the way:

"If the question is whether a given transaction is such as to attract a statutory benefit, such as a grant or assistance like legal aid, or a statutory burden, such as income tax, I do not think that it promotes clarity of thought to use terms like stratagem or device. The question is simply whether upon its true construction, the statute applies to the transaction. Tax avoidance schemes are perhaps the best example. They either work (Inland Revenue Commissioners v. Duke of Westminster [1936] AC 1) or they do not (Furniss v. Dawson [1984] AC 474.) If they do not work, the reason, as my noble and learned friend, Lord Steyn, pointed out in Inland Revenue Commissioners v. McGuckian [1997] 1 WLR 991, 1000, is simply that upon the true construction of the statute, the transaction which was designed to avoid the charge to tax actually comes within it. It is not that the statute has a penumbral spirit which strikes down devices or stratagems designed to avoid its terms or exploit its loopholes. There is no need for such spooky jurisprudence." (Norglen Ltd (in liquidation) v Reed Rains Prudential Ltd [1999] 2 AC 1 at 14) (He omitted the last sentence in his citation of that passage in MacNiven v. Westmoreland Investments [2001] UKHL 6 [2001] STC 237).

14. Neither the Special Commissioners nor the Chancellor thought that Ernst & Young's structure "worked". Prepayments of part of the final principal exchange, to use those advisers' own description in their slide presentation, do not come within section 151(1)(b). This conclusion does not derive from a process of changing the character of the transaction. Neither the Special Commissioners nor the Chancellor has sought to substitute one transaction for another on the grounds that both are economically equivalent. Their approach has been no more than to construe the particular taxing provision, in the light of its purpose, and then to apply it to the facts. That this is the correct approach needs no repetition of well-known authority (e.g. Lord Cooke in IRC v McGuckian [1997] STC 908 at 920).
15. S.151(1)(b) draws a distinction between payments made to secure a contract and the principal payments exchanged on maturity. Payments of part of the final principal do not cease to have that quality merely because it is agreed that they should be made in advance.
16. Nor did such payments acquire that quality which Mr Peacock accepted payments within s.151(1)(b) must display, the quality of an inducement. Payments within s.151(1)(b) are those which the counter-party, RBS or GSI, requires as consideration for agreeing to enter into the contract to buy or sell the foreign currency. They are conceptually distinct from the sums paid to buy or sell the currency. Only the timing of the payments of principal created what was said to be the need for an inducement. True it is that RBS would not have agreed to sell €500m for as little as £244m but for the payment Prudential made of £65m. But Prudential itself created the need for the inducement by entering into an agreement to pay only £244m on maturity. GSI would not have agreed to buy $250m for as much as £203m but for the payment Prudential made of £40m. But Prudential created the need for the inducement, by selling $250m for £203m. GSI did no more, on maturity, than to return the £40m which Prudential had deposited earlier.
17. Only Mr Peacock's unruffled advocacy has led me to wander from the path Mummery LJ has encouraged this court to follow, "there is no point in appeal court judges saying things at length simply for the sake of saying something" (R (Balding) v SSWP [2007] EWCA 1327). The Special Commissioners and the Chancellor gave reasons for dismissing this appeal, which I gratefully adopt. I would dismiss this appeal.

Lord Justice Laws:

18. I agree.

Lord Justice Mummery:

19. I also agree.